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Gold: Is The Price Too High?

  • Written by Syndicated Publisher No Comments Comments
    August 25, 2012

    An article by Michael Edesess summarized Erb and Harvey’s comprehensive research on the wisdom of owning gold. Their conclusion was that gold is not a particular good investment. But why do so many of us believe otherwise? And why, if gold is not useful, does the US government hold on to 8,000 tons of it? – The answer is: “In Gold We Trust“.

    It is true that there were long periods when gold did not provide good returns, but there were also times when the returns were spectacular. Like with any other investment, one should be invested when the price goes up and disinvested when the price declines. Buy-and-hold for any investment not paying substantial dividends works only in bull markets; it is a loss maker in bear markets, and gold is no exception to this.

    In my article Get Ready for the Next Great Bull Market I showed that one can use the concept of T Theory® to determine periods when one could expect superior returns from the stock market. Similarly, one can apply this method also to estimate the time periods when the price of gold should advance.

    The above chart from Terrence Laundry (T Theory® Foundation, Inc.) is dated February 27, 2004. The Gold Mega-T projected then a 20 year advance for the gold price to the year 2020. At that time when the chart was produced the gold price was about $400 per ounce, near the top of the range which prevailed for the preceding 20 years ($250 to $450 per ounce). One would probably have been extremely skeptical then that gold would advance significantly, discouraged by two decades of poor performance. But advance it did, to about $1,650 by now, providing an average annual return of over 18% for the last 8 years to astute investors. This was not a bad investment by any means.

    Above is a semi-log graph of the price of gold – a repeat of the first chart, but over a longer time period. The section of the graph, from 2002 to 2012, is almost a straight line. One can see that the gold price declines during the years 2008 and 2012 are hardly visible and do not interrupt the upward trend of the price. If this trend continuous to the year 2020 (according to T Theory®), then the price of gold will go much higher. (A comprehensive analysis of the function of gold in the monetary system is provided by Scott Minerd in this commentary. He poses the question whether gold at the current price is underpriced.)

    In conclusion, it must also be pointed out, that as one nears the final date at the right end of the T-bar, late rallies can represent the speculative “blow off” which would leave gold vulnerable to major declines during a possible subsequent bear market.

    Georg Vrba is a professional engineer who has been a consulting engineer for many years. In his opinion, mathematical models provide better guidance to market direction than financial “experts.” He has developed financial models for the stock market, the bond market and the yield curve, all published in Advisor Perspectives. The models are updated weekly. If you are interested to receive theses updates at no cost send email request to vrba@snet.net.

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    Images: via Flickr (licence attribution) 

    About The Author

    My original dshort.com website was launched in February 2005 using a domain name based on my real name, Doug Short. I’m a formerly retired first wave boomer with a Ph.D. in English from Duke. Now my website has been acquired byAdvisor Perspectives, where I have been appointed the Vice President of Research.

    My first career was a faculty position at North Carolina State University, where I achieved the rank of Full Professor in 1983. During the early ’80s I got hooked on academic uses of microcomputers for research and instruction. In 1983, I co-directed the Sixth International Conference on Computers and the Humanities. An IBM executive who attended the conference made me a job offer I couldn’t refuse.

    Thus began my new career as a Higher Education Consultant for IBM — an ambassador for Information Technology to major universities around the country. After 12 years with Big Blue, I grew tired of the constant travel and left for a series of IT management positions in the Research Triangle area of North Carolina. I concluded my IT career managing the group responsible for email and research databases at GlaxoSmithKline until my retirement in 2006.

    Contrary to what many visitors assume based on my last name, I’m not a bearish short seller. It’s true that some of my content has been a bit pessimistic in recent years. But I believe this is a result of economic realities and not a personal bias. For the record, my efforts to educate others about bear markets date from November 2007, as this Motley Fool article attests.